Pushing the frontiers of ILS

Insurance-linked securities (ILS) has a history of finding innovative ways of structuring insurance risk transfer to suit capital market investors, according to Herbie Lloyd, chief investment officer of non-life at ILS asset manager Securis Investment Partners.

“Beyond the more traditional peak-region, natural catastrophe risks, ILS can be a suitable home for several other types of insurance-related classes,” Lloyd explains.

“New growth areas will depend on a few key factors including structural suitability, limited stock market/credit exposure, whether the term/duration is appropriate for the mandate (typically shorter-tails are required), plus the robustness of data, loss reserving and modelling.”

“The fundamental positive attributes of the asset class persist regardless of any individual hurricane season.”

Exploration

Driven by the broad potential, Securis has created a new insurance solutions group to explore whether other types of risk lend themselves to ILS risk transfer.

It’s early days, with Securis still in the primary stages of scoping out new opportunities. One area Lloyd believes could be “very fruitful” is within the financing space, where Securis securitises against insurable assets which are ring-fenced in the case of insolvency.

“We have longstanding standing expertise of this on the life side—this same concept and structuring could be applied to many other types of risk,” says Lloyd.

The new group is just the latest move that Securis has made to increase its depth and breadth of knowledge in ILS. Founded in 2005 by former Morgan Stanley executives Rob Procter and Espen Nordhus, the ILS asset manager now has offices in London, Hamilton, Atlanta, Geneva, Tokyo and Zurich.

London was the natural choice for Securis’ head office, due to its status as a global financial centre, access to Lloyd’s and re/insurers, the talent pool and the proximity to a major investor base.

The ILS asset manager opened a Bermuda office in 2014, recognising the need for a footprint in another major re/insurance hub and the associated benefits for sourcing investments, particularly from the US.

Lloyd says: “The Bermuda ILS market has grown quite rapidly in recent years, and although the announcements on upcoming tax changes may have major implications on its continued attractiveness as a reinsurance hub relative to other jurisdictions, it’s very early to make a judgement.

“In parallel, London, Singapore and other jurisdictions are actively seeking to become more welcoming to ILS and have the advantage of deep roots in the global financial markets and associated infrastructure and talent that comes along with it.

“We believe outlooks for the London and Bermuda markets are positive and we value our presence in both.”

Pandemic possibilities

While there may be many pockets of potential, according to Lloyd, the role that could be played by ILS in helping to increase capacity for pandemic insurance is limited. Over the last 12-plus months, many of the repercussions from COVID-19 have highlighted a large protection gap across life, health and business interruption insurance, he adds.

“Ideally, we would like to think that insurance, and particularly ILS, can bridge the pandemic insurance gap. However, there are two major factors which inhibit our ability to take on this type of risk,” he explains.

The first, says Lloyd, is the systematic nature of the risk, with events spanning multiple regions simultaneously, and (critically for Securis’ investors) correlating with broader financial market volatility.

“The second issue is the extent of influence of human behaviour, politics and medical innovations—which makes this type of risk very difficult, if not impossible, to price and monitor accumulations satisfactorily,” he explains.

With the possible exception of parametric products, Lloyd believes that the appetite overall for pandemic risk will be fairly limited going forward.

However, while pandemic insurance may not yet be on the horizon, environmental, social, and corporate governance (ESG) strategies are quickly shifting into focus.

“As part of the growing movement from investors to seek and support ESG-friendly investment strategies, we have seen attention increase significantly on the ESG characteristics of our portfolios,” says Lloyd.

“Our focus has generally been on the end investment, which includes the ESG risks and attributes of the counterparty and of the underlying insured policies. Clearly there is potential to assess and improve ESG qualities elsewhere in the chain, such as collateral assets,” he adds.

The World Bank Sustainable Development Bonds—which support the financing of a combination of green and social projects, programmes, and activities in member countries—are well established and provide a “compelling option to integrate sustainability goals”.

“We have seen several other entities develop credible alternatives with a sustainable or responsible investment angle, and it is an area we expect will grow,” says Lloyd.

“It is very important however that the quality, security and liquidity levels of the assets are maintained as our investors are seeking only to take on the insurance-related risks.”

Outlooks and opportunities

A core part of Securis’ underwriting process consists of due diligence: when the ILS asset manager assesses investment opportunities, it considers far more than the modelled returns.

Other considerations also form part of the firm’s ESG framework, where it scores each of the investment opportunities on the basis of governance factors, alongside environmental and social aspects.

As an ILS manager investing in multiple different types of ILS instrument, part of Securis’ portfolio strategy is driven by the qualitative differences between the instruments. For example, there is often a trade-off between the risk/return profile versus the transparency of data, robustness of the contract and structure, scope of cover and other factors.

According to Lloyd, at an investment level, factors which can be very impactful on loss experience include things such as:

• The counterparty’s approach to risk selection, underwriting and risk management/accumulation control;
• Its claims handling processes and resources;
• How much of a handle it has on large loss development and how good it is at predicting ultimate losses;
• The quality and completeness of exposure and claims data;
• Its transparency and willingness to share information;
• The motivation for purchasing protection;
• The financial strength and long term outlook of the cedant; and
• The alignment of interest with their risk transfer partners.

In the last few years, the ILS market has experienced a number of different types of catastrophe losses with counterparty performance often varying significantly. This data has helped Securis form a more comprehensive view of each opportunity, informing its investment decision-making and ultimately its portfolio construction.

“Like the broader reinsurance market, following a benign period of activity between 2012 and 2016, ILS has endured a tougher period from 2017 to 2020 with significant levels of insured losses from hurricane events,” says Lloyd.

He adds that this has naturally led investors to question the validity of pricing models, the potential effects of climate change and reassessing the relative attractiveness of ILS versus other asset classes.

This means it’s now an important season for ILS performance, claims Lloyd. A year of light hurricane losses will provide some much-needed relief for ILS managers and their investors, he adds, while significant insured losses would “very likely exacerbate the pressure and further increase investor scrutiny”.

Lloyd concludes: “We believe investors in the ILS asset class need to take a long-term view of their allocation, appreciate its cyclical nature, and size it appropriately for their portfolio.

“The fundamental positive attributes of the asset class persist regardless of any individual hurricane season: diversification, attractive risk-adjusted return potential and typically ESG-positive characteristics.”